A health savings account (HSA) can be a great way to save money for medical expenses and even for retirement. But they do have rules you have to follow in regards to how much you can contribute.

If you go over your contribution limits, that money is an excess contribution. There are a few ways to deal with excess contributions. No matter which option you choose, it’s always best to try to fix the mistake as soon as you realize it.

Why the IRS sets limits to contributions

The IRS sets annual contribution limits because HSAs offer three main tax benefits:

1. Your HSA contributions are tax deductible.

2. If you invest your HSA money, the earnings grow tax-free.

3. You can withdraw your HSA money tax-free when spending it on qualified medical expenses.

If you receive your HSA as a benefit from your employer, you can take it with you if you leave your job. So you own the account and can take it with you throughout your career. Even better, there is no deadline to use the funds you contribute in your HSA. You can save them for a big planned medical expense, or keep them growing until retirement if you want.

You may have noticed tax-advantaged accounts, like your 401(k), Roth IRA, or 529 plan, have contribution limits. Otherwise, folks could get away with major tax savings — more than the IRS would like. Your HSA is no different. Even when you get tax breaks, the IRS still puts limits in place and works to ensure everybody plays by the rules.

How limits are set

HSA contribution limits go by the calendar year and are adjusted for inflation. So even if you enrolled in your HSA mid-year, or your plan year runs on a different schedule, you are still subject to calendar year contribution limits. Limits change every year, so make sure you stay up to date and don’t reference limits from the previous year.

If you are enrolled in your HSA the full calendar year and your health plan doesn’t change, it is pretty straightforward to understand your contribution limit. But there can be a few factors that make it trickier:

1. Multiple sources contributing to your HSA. Anybody can contribute to an HSA, so if you have your employer, yourself, and a generous family member all contributing, you have to make sure to coordinate your efforts so you don’t go over the limit.

2. Gaining or losing coverage mid-year. If you gain or lose coverage under a high deductible health plan (HDHP) during the year, you will change your HSA eligibility status. If you are not eligible for an HSA during the entire calendar year you have to either adjust your contributions accordingly or make sure you qualify under the last month rule. Either way, it’s important to be aware of your HSA eligibility and contribute accordingly.

3. Changing plan type mid-year. The contribution limits are different for individual and family plans. If you got married during the year, or your spouse got other coverage and left your plan, you experienced a change in plan type. You have to make sure that you don’t go over the individual limit in the months you are an individual and vice versa for family plans.

No matter what situation you are in, it is a smart move to know your contribution limit every year, just like you would your income for the year, and stay on top of the contributions to your HSA.

Penalties for contributing too much

There are three consequences for making excess HSA contributions, which the IRS outlines in publication 969:

1. 6% excise tax on the excess contribution

2. Income taxes on the excess contribution

3. Income taxes on any earnings the excess contribution made

It is important to be aware that excess contributions and earnings from those contributions are subject to income tax, particularly if your HSA is invested.

How to fix over contributions

If you realize you have made excess contributions to your HSA it can feel like a big mistake. But the good news is that there are ways to fix it and move forward.

Option 1: Withdraw the Excess

This is by far the most straightforward option, and it is one that many people choose when they make excess contributions.

If you realize you have made an excess contribution before the tax year ends (usually April 15), take it out immediately. You can take out the excess contribution by making a request with your HSA provider, which may involve filling out a form or two. If you have been contributing to your HSA via payroll, you should also inform your employer. Once you take the money out it will be regular taxable income earned.

Here's important information to keep in mind:

• If you remove the excess contribution before the deadline for filing your personal income tax return, you won’t be subject to excise tax.

• If you remove it before the end of the calendar year, you typically won’t need corrected tax forms.

• If you remove it after the end of the calendar year, but before the end of the tax year, you won’t be subject to excise tax, but you may need corrected tax forms.

• If you remove it after the tax year has ended, you will be subject to excise tax for that year (and all other years you keep the excess contribution in your account).

Option 2: Do nothing

We get it. You’re busy, and taxes can be a big headache. It may be tempting to ignore excess contributions and hope that nothing will go wrong, but this is a bad option.

If you do nothing, your excess contributions (and associated earnings) will be subject to income tax and excise tax in the year you made them. This alone may seem bad enough, but they will also be subject to excise tax every year until they are removed. That’s definitely a good reason to take action the moment you figure out you have excess contributions.

Monitor your contributions to avoid future issues

HSAs offer a plethora of tax benefits, and they can be a great way to save money for medical expenses and for retirement. But they do come with some responsibilities, among which is making sure you follow contribution limits. Before you set up your HSA contributions for the year, take a look at the new IRS limits and make sure that all of your contributions will stay below that number. If your eligibility status or plan type is going to change throughout the year, make sure you are aware of how that impacts your limit. Doing some preparation and planning goes a long way when it comes to avoiding penalties when you contribute to your HSA.